Ever notice how your loan’s base rate is different from the annual percentage rate (APR)? It’s important to understand how your mortgage’s interest rate works — before you sign the paperwork on that home for sale in Sioux Falls, SD — since it’s what determines what you’ll really pay to borrow that money.
What does your APR tell you that your base rate doesn’t?
The base rate determines what your monthly mortgage payment will be. The APR, on the other hand, spells out total cost over time and includes any fees and closing costs paid to third parties, such as brokerage fees, processing fees, underwriting fees, title insurance, appraisal costs, and mortgage points. Depending on the loan, points can either lower the interest rate by a percent for each mortgage point paid or cover origination costs.
“The difference between the two is that your base rate is what your contract rate will be, and the APR is that figure plus any fees to third parties that are added on,” says Chris Copley, regional sales manager at TD Bank.
When shopping for loans, “one company may be charging you significantly more fees than the other, and the way to see that would be to compare the APR on the [Federal Reserve’s Truth in Lending Act and Regulation Z (TILA-RESPA) Integrated Disclosures],” says Copley. The Loan Estimate and the Closing Disclosure documents include the loan balance, period, payment, base rate, APR, all the fees paid to your lender and third parties — basically, a full breakdown and every detail of your loan. “Sit down with your loan officer to go over each line in [these documents] so you understand what’s included in the APR calculation,” he adds.
Here’s how it works
Let’s compare two $100,000 30-year mortgages with different base rates. With a 3.5% interest rate, the monthly payment would be $449. But the monthly payment on that same mortgage at a 4% interest rate would be $477. The rate and payment on a fixed-rate loan won’t change for the duration of the loan, but the interest rate on an adjustable-rate mortgage could — and probably will — change. So if your 3.5% interest adjusts to 4%, you’re paying $28 more per month — $336 more per year. This is why you need to know your base rate, and why you might choose to opt for a fixed-rate loan instead of an adjustable-rate loan.
But even if the base rate on two fixed-rate loans is the same at 3.5%, what you pay over time can be vastly different because of potentially added fees, which can vary from lender to lender and are factored into the APR. All banks calculate mortgage APRs the same way, with the acceptable formula outlined in the TILA-RESPA Integrated Disclosures — but the fees they charge you could vary. It’s up to you to determine which APR (and lender) is best for you and your finances.
“The APR is intended to help shoppers compare borrowing costs among different lenders,” says Nancy Harmon, senior vice president of home lending solutions at Citizens Bank. “Keep in mind that interest rates fluctuate daily, and if you aren’t comparing APRs generated on the same day for the same product type and repayment term, you may not be comparing apples to apples.”
What do you think is the most noteworthy difference between base rate and annual percentage rate (APR)? Share your thoughts in the comments below!